Tezos: is it a revolution or a scam?

Tezos has raised almost a billion dollars in order to build a self-amending ledger. Now they are fighting a securities fraud lawsuit.

Tezos: is it a revolution or a scam?

Tezos, the second largest ICO ever that has raised more than $230 million, is now at risk to not deliver anything due to an internal conflict and its founders are now about to face a securities fraud charge as well as a potential class action lawsuit. Our team of cryptocurrency analysts at Team Saturn would like to present you with an overview of what's going on with tezos.

Disagree with us? Let's discuss Tezos on our forum.

What is Tezos

After the wild success of Ethereum, the so called second generation blockchain, people have started to wonder what the third generation blockchain is going to look like. Tezos offers an answer to this question.

Tezos sees itself as the end-all be-all of cryptocurrencies. Straight from the whitepaper: “Although most alt currencies harbor their own source of innovation, they have no means of adopting the innovations of other currencies which may succeed them.”

You can think of it this way.

  • Bitcoin is the first generation blockchain. It supports one token, and the rules are fixed. Upgrades to the network are achieved via hard forks.
  • Ethereum is the second generation blockchain. It supports creation of infinite amount of tokens and supports execution of smart contracts. These smart contracts are definitely the killer feature, and even though smart contracts are immutable, unchangeable once created, it is possible to create upgradeable smart contracts that are governed by some consensus mechanism. However, the rules of the blockchain network itself are fixed and not upgradeable without a hard fork.
  • Tezos is the third generation blockchain. It takes the abstractions one level deeper and stores the rules that govern the network on the blockchain itself. This means that when a new idea arises it is possible to upgrade the network without a hard fork. Thus, it is an upgradeable blockchain.

It's worth noting that the Tezos blockchain is still not implemented, it only exists as an idea and a whitepaper.

Scandal among founders

On October 18th the news broke out that not everything is going smoothly between the founders. Here's what Reuters reports on the matter:

But the venture is now in danger of falling apart because of a battle for control playing out behind the scenes, Reuters has learned. The acrimonious dispute pits Tezos’ two young founders – Arthur and Kathleen Breitman – against Johann Gevers, the president of a Swiss foundation the couple helped establish to handle the coin offering and promote and develop the Tezos computer network. Under Swiss law, the foundation is supposed to be independent. It holds all of the funds raised, which have mushroomed to more than $400 million in value because the contributions were made in two cryptocurrencies – bitcoin and ether – that have appreciated sharply. But the Breitmans, who still control the Tezos source code through a Delaware company, are seeking to oust the head of the foundation.

In short, instead of working on the code of the new blockchain, the two founders, husband and wife Breitman, are now fighting the president of the Swiss Tezos foundation that they've established over who gets the money.

What do experts have to say?

Experts highlight the following problems with Tezos ICO.

  • Uncapped ICO, allowing the founders to collect unlimited amount of funds. This allows the founders to make a huge bank and run away with the money, as well as lowers the return on investment that the project's backers might have had. If the ICO was capped at, say, $100 million, then this additional demand of $150 million would have gone into trading Tezos's futures and would make the token go up in price.
  • Secondly, the background of Tezos is completely revised and modified according to their whims. They claim they had a large team working on the project for 4-5 years full-time. Even a cursory glance exposes that one person worked on Tezos while working full time for a major bank and that the team grew insignificantly 6-12 months before ICO. They even changed their LinkedIn profiles to revert this history. Official tezos resource cites development began in 2014 and with a full staff of 10 core developers. It looks like Arthur Breitman and the gang modified their LinkedIn pages after the fact to remove full time employment at their day jobs and replace it with full time employment at Tezos.
  • No guarantees for investors. In early July, the Tezos foundation ran a fundraiser to fund the project's development (R&D, Bizdev, etc.). At the time it did not have funding (or very little). Its current treasury comes from that fundraiser.

It is an "ICO" because in exchange of your donation, the foundation will recommend a token allocation for you in the genesis block. Nothing prevents anyone to create a "concurrent" genesis block with different allocations though. It's just that the chances are people are going to follow the one the foundation recommends.

  • Lack of transparency and broken promises. Tezos has created a new smart contract language called The Michelson. The last post on the michelson page in the rubric called "A contract a day" has been on August, 24th.
  • More lies in marketing material. The Breitmans hired Strange Brew Strategies, a U.S. communications company, to promote their project, and Reuters wrote a news story on May 5 about Draper’s involvement.

In pitching the story to Reuters, John O‘Brien, a principal of Strange Brew, had made claims about Tezos’ progress. He wrote: “The applications of Tezos, ranging from derivatives settlement to micro-insurance, are real and recognized by industry giants. Ernst & Young, Deloitte, LexiFi, etc. have adopted Tezos in their development environments and labs.”

On Oct. 3, a spokeswoman for the accounting firm Ernst & Young told Reuters: “The statement is not correct. EY has not adopted Tezos.” A spokesman for Deloitte said Tezos’ code is “one of many technologies we’re considering” with blockchain, but it’s “still early stage and we haven’t used the technology for a client project.”

Jean-Marc Eber, CEO of the French software company LexiFi, said, “The sentence, as stated, isn’t accurate and unfortunately exaggerated, to say the least.” While there had been “informal contacts,” he said, “at this stage, LexiFi has not adopted Tezos’ technology in its development environment or labs.”

Securities fraud charges and class action lawsuit

It is important to understand that the SEC, the american body that governs securities, operates on a precedent basis. This means that ICOs will be unregulated up until the first lawsuit that rules that issuing an unregulated ICO is considered fraud.

That's grist for the SEC enforcement mill.
Understand how the SEC works. They're complaint-driven. After a few "I lost money on Zowiecoin after they didn't do what they said they'd do" complaints, a case gets assigned to a staff investigator. They dig up the obvious stuff quickly, and if it looks like there's enough bad stuff, the slow process of doing something to the people behind Zowiecoin starts moving forward. The SEC announces about two enforcement actions a day.
We'll start seeing SEC actions once ICOs crash and there are angry investors.

And it looks like the wheels are turning with respect to ICO regulations already. As of November 3rd, a lawsuit seeking class action status has been filed in California against the founders and promoters of the controversial Tezos blockchain project.

Submitted on Oct. 25 in the San Francisco branch of the Superior Court of California, the lawsuit names multiple defendants, including the Breitmans and Gevers.

The suit, filed by San Diego-based law firm Taylor-Copeland Law on behalf of plaintiff and Tezos ICO contributor Andrew Baker, alleges that the defendants violated U.S. securities law through the token sale. Specifically, the defendants are being accused of selling unregistered securities, committing securities fraud, false advertising and unfair competition ("by making material misrepresentations and omissions").

When reached for comment, Baker Marquart attorney Brian Klein, who is representing the Breitmans, said that that his clients planned to “aggressively” fight the lawsuit.

"This lawsuit is without merit for a host of reasons. Kathleen and Arthur Breitman, who are brilliant entrepreneurs and visionaries, are going to aggressively defend themselves. They should never have been sued," Klein told CoinDesk.

"As a general matter, the Foundation does not comment on potential litigation," Gevers said when contacted by email.

Strange Brew Strategies declined to comment when reached.

What's going to happen?

tezos pre-launch chart

Tezos ICO investors are yet to make a profit while Bitcoin and Ethereum are growing

Nobody knows what's going to happen next. It looks like the SEC is going to put its foot down with regards to ICO regulation. It also looks like Tezos' code development is going to grind to a halt now that the whole team is facing not only internal conflicts, but now also a high profile lawsuit that could put the founders behind bars for up to 20 years.

In short, we recommend the following to all ICO investors.

  • Do not invest in uncapped ICOs.
  • Do not be fooled by marketing materials, celebrity endorsements and linkedin pictures. Having a big name on the ICO team page is no guarantee of future profit.
  • Do your own research or buy research from trusted sources. A lot of what's going on in the space today involves very complex mathematics and computer science buzzwords. Make sure you understand every word or hire an expert that will be able to break the project down for you in a way that you will understand. Do not be fooled by smart-sounding marketing.
  • Be wary of ICOs without a working product.

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